1. a. What are the three forms of market efficiency we have learned about and ho
ID: 2635563 • Letter: 1
Question
1. a. What are the three forms of market efficiency we have learned about and how are they defined.
b. You have discovered a profitable trading strategy that allows you to consistently make abnormal returns in the stock market. The strategy is remarkably simple: Buy a stock after it has gone up by 10%. Sell it after it has gone down by 10%. Is this consistent with weak form market efficiency? Why or why not?
c. When a firm announces an unusual increase in earnings, what do you expect the stock price reaction to be on the day of the announcement if markets are strong form efficient with respect to this announcement? Explain
Explanation / Answer
Answer-1(a)-
The common type of efficiency referred to in financial markets is the allocation efficiency, or the efficiency of allocating resources.A trait of allocatively efficient financial market is that it channels funds from the ultimate lenders to the ultimate borrowers in a way that the funds are used in the most socially useful manner.
Three forms of efficiency-
1. Weak-form of efficiency
In this kind of market, we should simply use a "buy-and-hold" strategy. Prices of the securities instantly and fully reflect all information of the past prices. This means future price movements cannot be predicted by using past prices. It is simply to say that, past data on stock prices are of no use in predicting future stock price changes. Everything is random.
2. Semi-strong efficiency
Asset prices fully reflect all of the publicly available information. Therefore, only investors with additional inside information could have advantage on the market. Any price anomalies are quickly found out and the stock market adjusts.
3. Strong-form of efficiency
Asset prices fully reflect all of the public and inside information available. Therefore, no one can have advantage on the market in predicting prices since there is no data that would provide any additional value to the investors.
Answer 1(b)- No, this is not consistent with weak form market efficiency,because in weak form of efficiency , we have to use "buy and hold strategy" in given case we are buying securities when prices up 10% and selling when prices goes down by 10% which is not correct.
Answer(c)-
When a firm announces an unusual increase in earnings, then no one can take advantage of that information because in strong form of market allinformation are available publicaly. The price of stock will increase to some extent by increasing in profit.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.